Wednesday, September 25, 2013

The Not So Mysterious World of Money

Before anything, let's make one thing clear, I love finance. I guess it's an offshoot to my natural love for economics. That being clear let's get on. What the hell is finance? Most of the people think Wall Street was full of geniuses who knew how make money from nothing. Of course this definition changed after 2008 (but the Street still attracts people from all over, Goldman Sachs' COO said the bank receives 21000 applications for its internships). People still think somehow that world of finance is alien to them. It is only natural to think of something like that when you don't have a clue as to what the hell is going on. Similar to how people think MIT students can literally fix anything from a rocket to an iPod (http://mitadmissions.org/blogs/entry/mit_brings_you_unwanted_attent)But it shouldn't be so. Finance and money are some of the most intuitive things I have ever come across. It's just that some fancy name keeps people from naturally guessing what's going on. And by finance I am not referring to those things that only people from MIT can understand like derivatives (they are still easy, but not so intuitive). What's a long position, short position, futures, P/E, Price to book et cetera. All these are some of the most intuitive things you'll ever come across. And help you realize finance wasn't and isn't some voodoo magic that only people in Wall sTREET control over or something. Okay, what the hell is a long position. Its the single most common strategy people use to make money off the stock market anywhere in the world. It means you are buying some stocks and holding on to them and hoping to sell them when the stock price goes up. When someone says I am long on XYZ, it simply means they have a bought a certain stock and are hoping that the price will go up so that they can make some money. Now what's a short position? It's literally the opposite to long position. Now let's say that in 2008 Lehman Brothers was going to fall. And being the heartless bastard you are, you wanted to make money off it. It turns out many of us are heartless and have invented a strategy to make money off even when the price of something falls. The way it works it simple. You borrow, say 1000 shares of Lehman at a price of $100 per share. You borrow and not buy. Right after borrowing it, you immediately sell the 1000 shares on the market for a total of $1,000,000 (1000*$100=$1,000,000). And then Lehman goes bankrupt and suddenly the price of one share is $10. At this time you buy 1000 shares at the price of $10, which is a total of $100,000. You return the 1000 shares you had borrowed and you sit on a cool profit of $900,000. You have no obligation apart from returning the shares, as you hadn't taken any loan, taken any money or anything. All you did is borrow shares and you gave those shares back. You sold the shares for 1,000,000 and you paid the 100,000 out of this and the rest of the money was pure profit. Doesn't sound that difficult, right?This is what attracts me the most to finance, business, and the related fields; it's all so intuitive that it's literally no less than you going "OMG that perfectly makes sense!". I'll try covering more of these topics in future posts. If you're interested in knowing more about any concept, feel free to drop a comment and pass along the URL to this blog.